Taper time - Five questions for the ECB

REUTERS

By Dhara Ranasinghe and Ritvik Carvalho
LONDON (Reuters) – The European Central Bank is likely to decide the fate of its 2.3 trillion euro (£2.05 trillion) stimulus scheme on Thursday in one of the ECB’s most keenly anticipated policy meetings for months.
Solid economic growth means the days of extraordinary stimulus are numbered, although anaemic inflation supports the case for dragging out asset purchases for as long as possible.
The balancing act facing the ECB has become a focal point for markets trying to assess just what shape a scaling-back or “tapering” of stimulus is likely to take. Here are the main questions investors want answered:

1. How much will the ECB trim its asset purchases by?
Many analysts expect the ECB to announce a cut in monthly purchases to 30 billion euros from 60 billion euros from January for nine months, following recent source-based stories suggesting ratesetters favour a “lower for longer” scenario.
A bigger point of contention is whether to keep the scheme open-ended by putting a nine- or six-month time frame for the reduced purchases or give a final end-date for the scheme, which is currently set to expire in December.
Analysts do not rule out a 12-month extension at an even lower pace of 20-25 billion euros a month.
The ECB’s QE programme – http://reut.rs/2y1TxhP
2. Will the ECB change its forward guidance?
The language in the ECB’s statement about policy rates remaining low until “well past” the end of quantitative easing is expected to stay in place.
The longer the ECB keeps monetary stimulus in place, the further back investors are likely to push expectations for a rate rise. Money markets no longer anticipate a rate rise in 2018 and many economists do not expect a hike until 2019.
The ECB could also reaffirm that it will reinvest the proceeds of maturing bonds, sending a clear signal that it will remain active in bond markets for some time.
ECB bond market reinvestments – http://reut.rs/2xZOYF2
3. Is the ECB still worried about the euro?
The single currency has declined almost 3 percent from a more than a 2-1/2-year peak above $1.20 since the last ECB meeting in early September, but concerns about currency strength remain on policymakers’ minds.
Market data indicates that investors still expect more gains in the currency, with weekly CFTC positioning numbers showing long euro positions near their highest on record while long-term investors such as central banks and sovereign wealth funds are still underweight the single currency.
The phrase “exchange rate” appeared 25 times during ECB chief Mario Draghi’s last press conference, the most of any conference held by Draghi or former ECB President Jean-Claude Trichet, according to Nomura analysis.
EUR Positions and EURUSD – http://reut.rs/2lc6IH2
4. What about bond market scarcity?
A scarcity of eligible government debt for ECB stimulus strengthens the case for tapering. The ECB is likely to be questioned about its technical constraints although analysts say more details on this are more likely to come in December.
One view is that the ECB could avoid hitting self-imposed limits by scaling back purchases of corporate bonds more slowly than those of government debt.
To make up for shortages of government bonds in much of the bloc including Germany, the ECB has been skewing asset purchases towards Italy and France. That helps explain why Italian bonds, in particular, have benefited from recent talk that ECB tapering is likely to be a drawn-out process.
Italy-Germany bond yield gap – http://reut.rs/2l9GwwH
5. Is the banking sector strong enough for tapering?
While macro-economic indicators may be reassuring policymakers that they can tighten financial conditions, there is still a large cloud hanging over the bloc’s banking sector.
For that reason, investors will be listening closely to what Draghi has to say about tackling the stockpile of bad loans in places like Italy. The ECB faces the dilemma of making sure banks set aside money to deal with this legacy problem but still have enough to lend out.
Policymakers need to be sure that the private sector will be able to provide sufficient credit to maintain the euro zone’s recovery if the central bank takes a step back.
Euro zone lending rises, bad loans fall – http://reut.rs/2xYYacz
(Reporting by Dhara Ranasinghe, Saikat Chatterjee, John Geddie and Ritvik Carvalho; editing by John Stonestreet)

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